CHAPTER 8

MEASURING GROSS DOMESTIC

OUTPUT AND NATIONAL INCOME
ACCOUNTING
8.1 The circular flow Model (2-sector)
8.2 Methods of calculating national income
8.2.1 The expenditure approach
8.2.2 The product approach
8.2.3 The income approach
(calculation of national income for
expenditure and product approach only)
8.3 Uses of National Income
8.3.1 Concepts of economic growth, real
and nominal value of national income, per
capita income
8.4 Problems in calculating national income
CIRCULAR-FLOW DIAGRAM

❖ A simple circular flow model containing two

sectors (business and household) and two markets
(product and factor)
❖ Illustrates the continuous movement of the
payments for goods and services between
producers and consumers.
❖ Illustrates how households and businesses interact
through markets for products and markets for
resources.
CIRCULAR FLOW OF NATIONAL INCOME IN A TWO SECTOR ECONOMY
NATIONAL INCOME

▪ The total market value of all final goods

and services produced by the country’s
citizens during a given time period,
normally for one year.

▪ National income accounts are used to

determine the current performance of the
economy.
 IMPORTANT CONCEPT IN MEASURING NATIONAL
INCOME

❖ Gross Domestic Product (GDP)

❖ Gross National Product (GNP)
❖ Market Price (MP)
❖ Factor Cost (FC)
❖ Net National Product (NNP)
❖ Personal Income (PI)
❖ Disposable Income (DPI)
NATIONAL INCOME IDENTITY
⦿ National Income = National Product = National
Expenditure
⦿ Thus, national income may be viewed as:
✔ the total output produced by nationally owned economic
resources during a year (output approach)
✔ the sum of wages, interest, rent, and profits earned by
economic resources engaged in producing the national
output (income approach)
✔ money spent to purchase the national output
(expenditure approach)
Gross Domestic Product (GDP)

Market value of all final goods & services produced by

factors of production located within a country in a given
year including output produced by foreign worker.

Excluded:
i) goods and services produced by Malaysian
citizens working overseas.
ii) Intermediate goods. (intermediate goods are goods
produced by one firm for use in further processing by
another firm – example tyre)
iii) Used good sold at current year (not counted in current
GDP because it was already counted when it was
produced).
GROSS NATIONAL PRODUCT (GNP)
measures the production of goods and services by
factors of production owned by a country’s
citizens, regardless of where the output is
produced.
Value of output produced by foreign workers
working in Malaysia is counted in GDP, but not in
GNP
Value of output produced in other countries by
Malaysian working abroad is counted in GNP, but
not in GDP
 GNP = GDP + net income from abroad

OR

GNP = GDP + factor income received from abroad

– factor income paid abroad
 Net National Product (NNP)

✔ NNP is defined as the market value of the net output of

final goods and services by a nation during a year.

✔ NNP is GNP minus the value capital consumption or

depreciation.

NNP also referred to as national income at market price.

National Income (NI)

NI at factor cost is defined as the total of all income
payments made to factors of production.
PERSONAL INCOME (PI)
PI is the income that actually received by individual and household
in an economy in a year.
The deductions made from national income are:
Corporate income taxes
Retained earnings
Social Security contributions – EPF and SOCSO
Insurance premium

PI = National income + transfer payments – corporate

income taxes – retained earnings – social security
contributions – insurance premium
DISPOSABLE PERSONAL INCOME (DPI)
The PI as defined above is not the income of any one
individual or household that is wholly used for
consumption.
Individuals will use a certain portion of their personal
income to make payments to the govt.

DPI = Personal income (PI) – personal

income tax
MARKET PRICE AND FACTOR COST

MARKET PRICE (mp) : Current Price in the market

through the forces of DD & SS.

FACTOR COST (fc) : Real prices earned by producers.

GNPfc = GNPmp - indirect taxes + subsidies

GDPmp = GDPfc + indirect taxes – subsidies

METHODS OF MEASURING NATIONAL
INCOME

Expenditure GDP mp =
Approach C+I+G+X-M

GDP mp = All final

Product Approach products in the
economy
Methods

Adding all the

Income Approach various types of
income paid to
firm and
household
APPROACHES TO CALCULATING GDP
Expenditure Approach
A method of computing GDP that measures the total amount
spent on final goods and services during a given period.
Product / Output approach
A method of computing GDP that measures the value of all
final goods and services produced by economic sectors, such
as manufacturing, construction, mining and quarrying,
agriculture, etc.
Income Approach
A method of computing GDP that measures the income
(wages, interest, rents and profits) received by all factors of
production in producing goods and services.
1. EXPENDITURE APPROACH (C+I+G+X-M)
NI is obtained by adding all the expenditure on goods and services in a
year
Made up of four economic sectors:
i. Personal consumption (C)
✔ purchase of goods and services by firms, individual or household.
✔ purchase of bonds and stocks are not included.

ii. Investment (I)

✔ any purchases of capital goods by firms to produce good/service.
✔ other terms used
i. changes in the firm’s inventories.
ii. inventories is stock of raw material.
iii. semi finished product.
iv. unsold final product.
iii. Government spending (G)
✔ expenditure made by the federal, state and local
government for final goods and services.
✔ e.g: cost of providing national defense, construction
of new building such as school, hospital and
payment of salaries to public servants.

iv. Net Exports (X-M)

✔ net export is the difference between the value of
exports and the value of imports
FORMULA FOR CALCULATING NATIONAL INCOME
(EXPENDITURE AND PRODUCT APPROACH)

Expenditure Approach Product Approach

GDPmp = C + I+ G + (X-M) GDPmp = Final Product in the

economy

GDPfc = GDPmp – Indirect Tax + Subsidy

GNPmp = GDPmp + net factor income abroad

GNPfc = GNPmp –indirect taxes + subsidies

National income (NI) = GNPfc – depreciation

EXAMPLE 1

COMPONENTS RM MILLION
1. Public Consumption 20 000
2. Private Consumption 30 500
3. Public Investment 10 600
4. Private Investment 15 000
5. Change in Stock 150
6. Goods and services exported 1 000
7. Goods and services imported 700
8. Net factor income abroad 100
9. Indirect taxes 200
10. Subsidies 500
11. Depreciation 50
12. Employees Provident Fund 200
13.Tax on personal income 400
14. Transfer payment 100
15. Social Security Contribution 100
16. Retained earnings 10
17. Insurance Premium Payment 100
Calculate:

GDPmp = C + I + G + (X-M)
= 20,000 + 30,500 + 10,600 +15,000 + 150 + (1,000-700)
= 76,550

GNPmp = GDPmp + net factor income abroad

= 76,550 + 100
= 76,650

GNPfc = GNPmp + subsidy – indirect taxes

= 76,650 + 500 – 200
= 76,950

NI = GNPfc – depreciation
= 76,950 – 50 = 76900

PI = NI + transfer payment – SOCSO – retained earnings – insurance premium

= 76,900 + 100 – 200 – 100 – 100 – 10 = 76,590

DPI = PI – Personal income tax

= 76,950 – 400 = 76190
Example 2:
Items (RM millions)
Exports 500
Personal consumption expenditure 1400
Changes in stock -40
Indirect business tax 30
Government expenditure 990
investment 1000
Personal income tax 80
Subsidies 30
Imports 400
Factors income paid abroad 80
depreciation 40
Factor income receive from abroad 90

Calculate:
1.GDPmp (3450)
2.GNPmp (3460)
3.GNPfc (3460)
4.National Income (3420)
PRODUCT APPROACH
NI is measured by net value of all final goods and services produced
by a nation during a year.

Only the money value of all final goods and services are included.

Raw materials and intermediate goods are subtracted from the value
of GDP to avoid double counting.

3 sectors contributing to the GDP:

1. Primary sector – mining and quarrying, agriculture, forestry, fishing.
2. Secondary sector – manufacturing and construction
3. Tertiary sector – electricity, gas and water; wholesale and retail
trade; finance, insurance, real estate and business services,
transport, storage and other services
Example:

Items RM (million)
Government services 1000
Net factor income 250
abroad
Transfer payments 150
Exports 1500
Mining and quarrying 1800 Calculate:
Manufacturing 1500 1. GDPmp
2. GDPfc
Indirect business tax 400 3. GNPfc
Depreciation 100 4. National income
Subsidies 150
Private investment 5000
Electricity, gas and 700
water
Banking and tourism 3000
Rent 200
Solution:

1. GDPmp = government services + mining and quarrying

+ manufacturing + electricity, gas and water + banking and tourism
= 1000 + 1800 + 1500 + 700 + 3000
= RM8000m

2. GDPfc = GDPmp + subsidies – indirect taxes

= 8000 + 150 – 400 = RM7750m

3. GNPfc = GDPfc + net factor income abroad

= 7750 + 250 = RM8000m

4. NI = GNPfc –Depreciation
= 8000 – 100 = RM7900
 Nominal National Income Real National Income

It is national income measured in It is national income measured on

current prices standard/fixed price
Considered changes in general
price level or inflation

Year 2000 Year 2009 Year 2010

Qty of national
5000 5000 4000
output

Price(RM) 1.00 1.50 1.50

Price Index 100 150 150

Nominal NI 5000 X 1 = RM5000 5000 X 1.50 = RM7500 4000X1.50 = RM6000

Real NI RM5000X100=RM5000 RM7500X100 = RM5000 RM6000X100=RM4000

100 150 150
26
 REAL INCOME, PER CAPITA INCOME AND GROWTH RATE
1. Real income
Real income or real GNP (or real GDP) is GNP measured on a fixed price or
base year.
Nominal GNP is measured in current price.
We can convert the nominal GNP to real GNP using a GNP deflator (same
cases with GDP).
GNP deflator is obtained by comparing the base year index with the current
year price index.

GNP deflator = current year price index

base year price index

Real GNP = base year price index x Nominal GNP

current year price index

= Nominal GNP
GNP deflator

(same formula can be used to calculate Real GDP)

Example:

If the current price index is 160 while the base year price index
is 100 and the nominal GNP is RM10,000 million, then the real
GNP is:

Real GNP = base year price index x Nominal GNP

current year price index

= 100 x 10,000 = RM6,250

160
or

Real GNP = Nominal GNP

GNP deflator

= 10,000 = RM6,250
(160/100)
2. Per capita income

Refers to average income per head of population

Used as index of change in the standard of living of a
country
Per capita income = National Income
Total population

E.g: The national income of a country with a total

population of 20 million is RM50,000 million. So the per
capita income is:
Per capita income = 50,000 = RM2,500
20
3. Growth rate
Economic growth of the country can be measured as a
gross domestic product (GDP) or growth national
product (GNP) based on real income.
The growth is the percentage change in the quantity of
goods and services produced from one year to another

growth rate (g) = Real GNP this year – Real GNP last year x 100
Real GNP last year

e.g: If the real GDP for year 2003 is RM232,359 million and RM248,954
million for year 2004, the growth rate from year 2003 to 2004 is:

g = 248,954 – 232,359
232,359
= 7.14%
Uses of national income
1. Standard of living comparison
Compare the standard of living of people in different countries at
different times.

2. Economic performance over time

Measure the performance of an economy over time

3. National Planning
NI statistics are very important tool for the government to formulate
its short term and long term economic planning.
To forecast future development based on current economic
performance.
To draft Malaysian Plan.

4. Sectoral contribution
Indentify the important sector that contribute toards economic
growth.
Before 1980s – agriculture sector
1980s – manufacturing
Now – services sector has become the major contributor
5. Economic policy
NI statistics are important tool in macro analysis.
NI estimates are the most comprehensive measure to aggregate
economic activity.
So future economic policies can be formulated

6. Inflationary and deflationary gaps

To know the purchasing power of money and help govt. implement
anti-deflationary or anti-inflationary measure to stabilize the economy.

7. Distribution of income
Among different sectors of production if the form of rent, wages,
interest and porfits.
DIFFICULTIES IN CALCULATING NATIONAL INCOME
1. Problems of non-monetized sector
Usually arise in most third world countries
Especially in agricultural sector due to large quantity of agriculture output
does not reach the market either consumed directly or exchange for other
goods and services

2. Problems of illiteracy
Small producer in third world countries are illiterate thus unable to keep
account of their productive activities.
Product that produced are self-consumption and not for the market –
record are not kept of their productive activity.

3. Problems of expertise
Lack of professional such as statisticians, researches, programmers –
major problem in third world countries

4. Problems of less sophisticated machinery

Non-availability of sophisticated machinery such as advanced computer
or program to compute national income.
5. Problem of double counting
Possibilities of intermediate goods being included in the national income
more than once.
The best way to avoid problem is calculate only the value of all final goods
and services.

6. Problem of false information

People do not disclose their income or underestimate their income to avoid
paying higher taxes.

7. Problems of multi occupation

People engaged in a number of economic activities which are not included
in the national income.
END